Muhammad Ayub Understanding Islamic Finance phần 10 pdf

460 Understanding Islamic Finance having a rational and sound theoretical basis and increasingly wider acceptance at a global level. The measures required for building an all-pervasive structure of finance and making it free from injustice and anomalies include the creation of asset-based money and promoting retail and corporate financial services on the basis of fair play and risk-sharing. Almost all Islamic countries are still borrowing through the conventional interest-based system and only a negligible part of their needs has been financed through Shar ¯ ı´ah-compliant instruments. The firm edict of the Shar ¯ ı´ah people against fixed-income securities, however, does not allow the use of conventional investment instruments. In realizing the real potential of Islamic finance, experimented and proved in recent years, these countries have to set a precedent for other countries of the world. The OIC or IDB may formulate financial packages for member countries, obliging them to resort to asset-based financing on the basis of Ijarah, Istisna‘a and Shirkah. If applied wholeheartedly on a larger scale, these modes of business and investment have the possibility of being used as an efficient alternative to interest-based deficit financing, along with the added benefit of disciplining fiscal behaviour. In such a case, each economy would be able to get real benchmarks for the pricing of goods, their usufruct and services, both in cash and credit markets, representing the real demand/supply scenario and the strength of the economy. Obtaining a benchmark for Shar ¯ ı´ah-compliant securities in the present situation is almost impossible. This is why, IFIs are currently obliged to adopt the interest-based benchmarks in almost all parts of the world, making the integrity of their operations vulnerable. If Islamic finance theory is adopted for retail and/or corporate banking on a smaller or larger scale, and not for the financial system as a whole, i.e. the governments continue to generate funds primarily from the conventional markets, it is not likely to have any visible impact on any economies of the world or their general populations. Accordingly, the economists and the policymakers are required to come out with confidence and dynamism against the syndrome of allowing the creation of monetary assets without any meaningful limit on the one hand and allowing a fixed rent on such assets on the other; and be encouraged to adopt the real economic activity-based regimes that allow ex post profit- or loss-sharing and fixed or quasi-fixed returns through pricing of real goods, assets or their usufruct. This would require some bold measures that, of course, are not novel, as these are being taken in many economies in various parts of the world. The conventional financial system has developed through a prolonged and continuous process, moving away from gold to the electronic medium of exchange. Correcting it to make it really helpful for human beings, just and conflict-free would also take a long time. However, the process of change has to be started with sincerity. Putting it on the right track would require a lot of work and sacrifice by present generations for the bright and safe future of mankind. To transform whole economies and make them Shar ¯ ı´ah-compliant, sooner or later the policymakers and planners will need well-defined phases and well-thought-out plans with committed and sustained efforts. This will require (i) identification of transformation require- ments in terms of laws, rules, regulations and institutional structures in different jurisdic- tions, and components of policies fitting into the overall implementation timetable; (ii) laying down a phased plan and the implementation mechanism; and (iii) feedback or con- tinuous review and evaluation in order to ensure proper application and to remove any obstacles. Application of a real-asset-based financial system by only a few countries could cause a critical problem for them, due to exogenous factors responsible for an increase in money The Way Forward 461 supply if most of the major economies of the world continue the present practices of money creation. To some extent, this problem can be tackled by facilitating closer linkages between the exogenous money and policies of the State in respect of capital flow, investment in the public and private sectors, fiscal, trade and pricing policies and the effective over-seeing role of the State. 18.3 POTENTIAL, ISSUES AND CHALLENGES FOR ISLAMIC BANKING In this section we shall discuss the issues, potential and challenges for Islamic banking and how best it can meet such challenges. Islamic finance has rapidly grown from a highly specialized niche market into a multi-billion dollar global industry, expected to continue double-digit growth in the coming decades. Islamic retail banks and non-bank financial institutions operating across the world already number in the hundreds, in both Muslim majority and Muslim minority countries. The IFIs’ product portfolio has significantly grown on account of innovative products, both for retail and corporate operations. Financial insti- tutions of the West and America, including Citigroup, Deutsche Bank, ABN AMRO, HSBC and UBS, are increasingly offering products based on the Shar ¯ ı´ah principles. 6 The experiences of Islamic banks in Kuwait, Bahrain, Saudi Arabia, Sudan, Britain and in other parts of the world point towards tangible success in the areas of product innovation, venture capital, equity finance, finance for trade, housing and other consumer needs and international syndication for trade and project finance deals. Owing to the growing amount of funds available with Islamic banks, refining of Islamic financing techniques and the huge requirement of infrastructure development in Muslim countries, there has been a large number of project finance agreements in the recent past, particularly in the Middle East region. Islamic banks now participate in a wide range of financing, stretching from simple Shar ¯ ı´ah-compliant retail products to highly complex structured finance and large-scale project implementation. These projects include the construction of power stations, water plants, roads, bridges and other infrastructure projects. Electronic money has also been introduced by a number of IFIs. A number of institutions, including Kuwait Finance House, Dubai Islamic Bank, etc., are offering credit cards, while debit cards have been issued by a large number of IFIs. National Commercial Bank of Saudi Arabia has introduced an “advance card”, which does not have a credit line and instead has a prepaid line. Added benefits are purchase protection, travel accident insurance without the involvement of interest and extra fees. This prepaid card facility is especially attractive to women, the young, the self employed and small establishment employees who sometimes do not meet the strict requirements of a conventional credit card facility. Some efficient and Shar ¯ ı´ah-compliant vehicles have been developed lately. Besides a large number of general Islamic funds, a number of multimanager funds have been established to ensure best practice and results without compromising on the Shar ¯ ı´ah compliance matters. A number of Islamic financial market indices have been developed that are observing screening and purification criteria for investment in equity markets. Some examples are the Dow Jones Islamic Index, Al-Meezan Islamic Investment Index and the Malaysian Islamic 6 For the evolution of Islamic banking and analysis of the movement, see Siddiqi, 2006a, pp. 1–48. 462 Understanding Islamic Finance Index. A large number of corporate bodies and sovereigns have been using Sukuk in place of interest-based securities for more than five years. The vehicle of Shar ¯ ı´ah-compliant Sukuk has been successfully introduced even in Japan and China. International infrastructure institutions like the Islamic Development Bank, Islamic Finan- cial Services Board (IFSB), International Islamic Financial Market (IIFM), General Council for Islamic Banks and Financial Institutions (GCIBAFI) and the International Arbitration and Reconciliation Centre for Islamic Financial Institutions (ARCIFI), Shar ¯ ı´ah support institu- tions like the AAOIFI and Shar ¯ ı´ah councils of various groups, as well as other commercial support institutions such as the International Islamic Rating Agency (IIRA) and the Liquidity Management Centre (LMC) are playing a crucial role in promotion and standardization of financial operations of IFIs. Bahrain is the main centre for Islamic finance in the Middle East region, playing a vital role in fostering Islamic banking operations and regulation. The ARCIFI is working in Dubai as a support institution to resolve disputes that may occur between industry participants and their counterparties. From this perspective, the discussion on issues, potential, challenges and the way forward for Islamic finance must take into account the factors that provide impetus and the driving force needed for the fast promotion of the emerging Islamic finance industry. These factors include: 1. An increasing demand for Riba-free investment instruments for religious reasons, which has been a catalyst for the emergence of financial institutions working on Shar ¯ ı´ah- compliant bases. Riba has been prohibited in the severest terms and a conscientious Mus- lim cannot harbour any idea about involvement in interest-based transactions. Islamic banking has thus enabled such people to fulfil their aspirations for doing business or investing their money without pricking their consciences. 2. The resurgence of Muslim cultural values, resulting in the desire to conduct financial business in accordance with the Shar ¯ ı´ah principles. 3. The active involvement of the Shar ¯ ı´ah scholars and experts in Islamic jurisprudence in coordination with bankers and the practitioners, which has been instrumental in improving the availability of innovative products and increasing awareness about the concepts and philosophy of Islamic banking. 4. The development of Shar ¯ ı´ah-compliant products and instruments of investment, which has facilitated gainful deployment of excess liquidity that IFIs had in the early years of their establishment and broadened the base of the Islamic capital market. 5. The standardization of modes and products on a Shar ¯ ı´ah basis and accounting and auditing procedures, particularly the AAOIFI’s Shar ¯ ı´ah Standards, which have played a crucial role in enhancing credibility, and hence demand, for Islamic banks’ products. Risk management, capital adequacy and corporate governance standards introduced/being developed by the IFSB have also played a significant role in providing recognition for Islamic finance. 6. The growth of surplus money in the Gulf region due to increasing petroleum prices and the growth of economies in Muslim countries. 7. Flexibility in the regulatory framework in a number of regions, and deregulation and privatization of financial institutions, which has also facilitated the growth of banking and non-banking financial institutions in Islamic as well as Muslim minority countries. For example, in the USA, more than two dozen Islamic investment institutions are providing needed facilities to communities who avoid Riba. This began when the Glass– Steagall Act of 1933 was repealed in 1999. Flexibility provided by the FSA in the UK The Way Forward 463 in respect of the treatment of IFIs’ deposits, stamp duty on mortgages (which needs only be paid once in a retail transaction) and accommodating Islamic banking practices has given a big impetus to the Islamic finance industry in the UK and ultimately in the whole of Europe. 8. The conversion of a few financially sound institutions in the Middle East to Islamic modes of business in recent years on account of increasing demand, which has also provided a self-enforcing impetus to the movement of Islamic finance. 9. The fact that, as investors are gaining awareness, high net worth individuals are shifting their investments to Shar ¯ ı´ah-compliant institutions. This is leading to the development of Islamic finance markets and the availability of a wider range of services. 10. The real-asset-based and ethical nature of Islamic financial products based on the avoid- ance of gambling and interest, which has increased demand for such investments and widened the IFIs’ customer base. In the light of the above, the way forward for the Islamic banking industry is to take advantage of all the above factors and explore other such factors in order to provide even more powerful impetus for its sustainable development, enabling it to contribute to the welfare of human beings on a wider scale. In the following paragraphs we shall discuss the potential of Islamic finance and issues and challenges that Islamic banking and finance face in optimally realizing their potential and developing on a sustainable basis. 18.3.1 Promising Potential The amazing development of Islamic finance in the last decade and analysis of the factors that served as driving forces for the fast growth is indicative of the huge potential for the industry in the future, because the factors will hopefully continue to provide impetus. An important observation to be made in this regard is that while firm foundations of the system have been laid down, the focus should now be on realization of the basic objectives of the theory of Islamic finance. In other words, potential should be related to the expectations of the pioneers of the concept of Islamic finance and the apprehensions of a large number of contemporary scholars, who are minutely watching the procedures, direction and trends of its growth in terms of the impact of the system in benefiting societies and removing the anomalies created by the conventional system. Having said that, the Islamic banking and finance industry has a large potential ahead in retail, corporate and investment banking and fund management. The characteristic of Islamic finance that all transactions must be based on fixed assets, services or instruments representing such assets or services, makes investment banking, fund management, and Sukuk issues, along with retail and corporate banking, lucrative for the financial institutions. To realize this potential, IFIs require structural adjustments enabling them to deal with real sector business, implementation of trading, leasing and real-estate-related contracts using both participatory and nonparticipatory Islamic modes of financing. Structural adjustments are necessary not only to consolidate the success achieved so far, but also to realize the huge potential in the areas of fund management and securitization, provide Halal and relatively better return flow to investors and thus contribute to economic growth and prosperity. 464 Understanding Islamic Finance Potential in Fund Management IFIs may engage in fund and portfolio management through asset management companies regulated by the central banks or the SEC, as the case may be in various jurisdictions. Broadly, the following may be the categories of funds: • funds yielding return with minimum possible variation: these funds can be based on short-term Murabaha and leasing operations of banks in both local as well as foreign currencies and hence can be made to offer minimal risk to the investors in such funds. Such low-risk funds, which would be earmarked for purchase of goods and their resale on mark-up and short- to medium-term leasing operations giving fixed earnings to the banks, would be best suited for risk-averse savers who cannot afford possible losses in PLS-based investments. • funds yielding high returns based on Musharakah or long-term leasing operations for those who are willing to take some risk for higher returns. Banks may offer a type of equity exposure through restricted/specific investment accounts, where they may identify possible investment opportunities from existing or new business clients and invite existing account holders to subscribe. Instead of sharing in the banks’ profit, the investors would share the profits of the project in which the funds were invested. Banks can also offer open-ended multiple equity funds to be invested in stocks. Banks may introduce domestic currency trade funds for those who want to invest their savings with minimal risk. The amount thus mobilized can be invested for financing SMEs and domestic and international trade. The experiences of Grameen Bank of Bangladesh and the Bangladesh Islamic Bank reveal that banks may invest such funds mainly for small- and medium-level business and trading activities wherein the default level/ratio is expected to be the lowest. Keeping in mind the relatively larger mobility of capital across the nations, banks may also set up international/foreign currency trade funds, which may finance imports/exports of clients, firms and industries. Potential Relating to Sukuk Sukuk, a by-product of the fast-growing Islamic finance industry, have confirmed their viability in mobilization of resources and their effective use for the benefit of both investors and fund users. Their growth is attributable to a number of factors, including their potential for liquidity and fund management. They could also be used as a tool for monetary policy and open market operations and for liquidity management. Sukuk create a framework for participation of a large number of people in financing projects in the public and private sectors, including those of infrastructure such as roads, bridges, ports, airports, etc., on the basis of various modes. A variety of target-specific Sukuk can be issued, keeping in mind the relevant Shar ¯ ı´ah rules. This requires appropriate enabling laws to protect the interests of investors and issuers, appropriate accounting standards, study of the targeted market, monitoring of standardized contracts, appropriate flow of financial data to investors and the provision of a standard quality service to the customers at large. The international institutions set up during the last decade to provide global acceptance for the Islamic finance industry, namely the Bahrain-based LMC, IIFM and IIRA, have to do a lot to make the vehicles of Sukuk, fund management and ultimately Islamic capital markets increasingly active and efficient. They have to lead the industry players to exploit The Way Forward 465 the potential of Shirkah-based Sukuk, because further reliance on Ijarah Sukuk alone, as witnessed over the last five years, may not be sufficient to realize the securitization potential of Islamic finance as a whole. 7 Potential in Specific Sectors Asset-based modes of Islamic finance are more suitable for enhancing business and for capital formation in priority sectors of small business, cottage industry and agriculture. If Islamic banks and NBFIs adopt structures and procedures to suit such sectors, it could be highly profitable for them, and beneficial for business and industrial communities and the related economies. This is because the financing of small-and medium-sized enterprises and micro finance have proved to be effective approaches for broad-based economic growth and alleviating poverty in the developing and emerging economies. Islamic micro finance institutions (IMFIs) would have fewer default, moral hazard and asymmetric information problems. In this respect, Habib Ahmed, an economist at the IDB, has undertaken a useful study for exploring problems and prospects of IMFIs, which readers may like to see for details. 8 Enhancing the role of the financial sector in micro-level businesses could mitigate the serious problems of unemployment and the low level of exports in developing countries. If suitably planned, financing of this sector could boost the development process. The value addition generated in these industries would favourably affect the income distribution. The post investment role of the financier, as required in Islamic modes of financing, could go a long way towards the development of SMEs and the economy if a full-fledged structure of financial help is provided through industry-specific and generalist models of investment. IMFIs can also benefit from various income sources like those of Zakat and Waqf institutions and use the resources for direct financing of needy small business enterprises, without the involvement of any middleman, thus benefiting themselves and the clients. For clients of high net worth and the big investors, banks may offer individual investment portfolios and investment funds in Shirkah-based and debt-creating modes, depending upon the risk profile of the fund owners. In such funds, banks may serve as a Mudarib or as an agent. As Mudarib, banks would get a share in the profit on a predetermined ratio, while as agent, they would get a fee and the rest of the profits/losses would go to the fund owners. 18.3.2 Issues in Islamic Finance Commensurate with the prospects of growth in the Islamic finance industry are some of the issues and challenges. Some major issues are discussed below. Shar ¯ ı´ah Interpretation: An Issue? A large number of experts and policymakers consider that different Shar ¯ ı´ah interpretation of some modes and concepts is a major issue hindering the development of Islamic finance. Is it really an issue or merely a buzz word? This, in itself, is a question. It seems that it is not as big an issue as some people consider; it is no longer a real problem. No doubt, in 7 Adam, 2005, pp. 371–400. 8 Ahmed, 2002, pp. 27–64. 466 Understanding Islamic Finance the wake of emerging issues in the fast-moving world of finance, some aspects will remain to be decided in the light of the Shar ¯ ı´ah principles, and the same may be resolved as and when confronted, but the major Shar ¯ ı´ah-related issues that the Islamic finance movement faced in the early years of its foundation have been resolved or cleared by dint of ample work by the jurists. The Islamic Fiqh Council of the OIC, the AAOIFI and the Shar ¯ ı´ah scholars in general have discussed at length almost all major areas and provided a number of alternatives to most of the conventional products, except derivatives based on interest or short-selling and speculative transactions in the Forex markets. Now the practitioners have to proceed on the basis of the achieved consensus. Product innovation from the Shar ¯ ı´ah perspective does not mean that alternatives must be provided for each and every instrument or product used by conventional institutions. This is not possible; a discipline based on ethics and just hypotheses cannot afford to follow any unethical system step by step. Islamic finance will have to observe certain restraints so that it does not become exploitative and unjust, as is the case with its counterpart, interest-based system. There are some unresolved issues as well, but these are not purely of Shar ¯ ı´ah inter- pretation; the practical difficulties and the ground realities have given rise to these issues. Therefore, such problems and issues can be resolved once and for all by a body of Shar ¯ ı´ah scholars like the OIC Islamic Fiqh Council or that of the AAOIFI. And if this is not possible, the Shar ¯ ı´ah boards/Shar ¯ ı´ah advisors of the respective banks may decide cases on merit by resorting to Ijtihad, subject to the widely accepted principles of the Shar ¯ ı´ah. Examples of such unresolved issues are the award of liquidated damages to the banks in cases of default on their receivables. In principle, the penalty paid by the defaulting client goes to the charity fund; if the default persists for longer periods, it will be harmful to the system, besides being unjust to the bank and the depositors. An accepted solution in this regard is that banks may claim their loss through a court or any independent arbitration; but on what firm basis the courts would be deciding is another related issue. Conventional opportunity cost per se should not be the basis for such award. Some Shar ¯ ı´ah boards allow the banks to charge defaulters a rate based on the income that they have earned from the similar portfolio in the related period. But the deciding factor should be the financial position and the behaviour of the client and the expenses and time involved in litigation, on the basis of which the court may allow some or the whole of the penalty to go to the bank. Another practice-related issue could be that of the liability of the banks’ shareholders towards investment account holders of Islamic banks. This is a complicated issue because it also involves conflict of interests; its solution lies in a firm regulatory framework with special emphasis on safeguarding the interests of the depositors. Losses to banks could be due to overexposure, lack of diversification, imprudent banking practices and/or actual business losses. The Shar ¯ ı´ah boards of the banks may decide the cases on merit, keeping in mind all such factors. As regards the big issues of Shar ¯ ı´ah interpretation, it is encouraging to observe that, lately, the practitioners in the Far East have started using genuine alternatives to interest (like Ijarah) for issuance of Sukuk, and it could be anticipated that in future, they will also change the basis of products based on the sale of debt and buy-back. Going forward, the focus of policymakers and product developers should be on development of the products, instruments and the Islamic finance industry by using the flexibilities already available and not wasting time and money on such areas that could lead only to the loss of integrity of the emerging discipline of finance. They should stick to the standards issued by the AAOIFI The Way Forward 467 that are based on the deep conceptual research by Shar ¯ ı´ah scholars under the aegis of the Fiqh Academy of the OIC. This is the only way to avoid inconsistencies in interpretation of Shar ¯ ı´ah law by different scholars. Integrity and Credibility The integrity of IFIs has unfortunately become an issue; a large number of people, inten- tionally or inadvertently, express doubts, not only about the credibility of the system but also about the intention and integrity of the scholars and the practitioners involved in the process of evolution. This has to be tackled with joint efforts by the Islamic banks, the cen- tral banks/regulators and the Shar ¯ ı´ah scholars if rapid growth of the emerging discipline of finance is the objective. Many academicians, policymakers, regulators, religious leaders and even those who are working with Islamic banks are not confident about the Shar ¯ ı´ah position of Islamic banks’ products. The integrity of Islamic financial institutions depends on: 1. The status of Shar ¯ ı´ah compliance of their products. 2. The impact of the products on the clients and the society or economy. 3. Professional competence and care for the interests of the stakeholders. 4. Behaviour towards and observance of Shar ¯ ı´ah norms by IFIs’ incumbents. As regards the first factor, Shar ¯ ı´ah scholars may play a crucial role in enhancing the credibility of IFIs. People with Shar ¯ ı´ah considerations normally approach the Shar ¯ ı´ah scholars to get advice for investment in Shar ¯ ı´ah-compliant avenues. But the problem is that many religious leaders do not fully understand the operations of IFIs. Hence, they give edicts prohibiting people to invest in any institution called a “bank”. To them, a bank cannot work on Islamic principles and any amount received or paid over and above the amounts deposited or taken from the banks is Riba, irrespective of the nature of banks’ operations. It is pertinent, therefore, that an association of IFIs in different countries or the central banks should launch programmes for awareness and education of such religious leaders, not only about the functions of banking and other intermediary institutions but also about the principles and philosophy underlying Islamic banking operations. At the very least, the Shar ¯ ı´ah Standards developed by the AAOIFI must be introduced to them in detail. This would enhance their confidence and enable them to create a positive impression of Islamic banking among the common people. Factor 2 above is very important in enhancing the credibility of Islamic banking. People generally question the impact of present Islamic banking practices vis-à-vis the impact of the conventional banks’ operations. Normally, Islamic bankers fail to defend themselves on this point because they do not have in mind such ideas; like conventional bankers, they are simply told how to earn profit. They must be given sound and intensive training about the philosophy and functioning of IFIs and the differences between the services of Islamic banks and those of their counterparts, and about how and to what extent Islamic banking practices could be useful for society. However, a pertinent point in this regard is that policymakers, product developers and those who are at the helm of affairs must bear in mind socio-economic considerations along with the profit consideration. Further, Islamic bankers and the public in general must be apprised of the role various modes of financing can play in socio-economic development. The stakeholders should also have knowledge of the limitations and challenges facing Islamic banking, due to which it might not be able to achieve the results proclaimed in Islamic finance theory, at least in the short or medium terms. 468 Understanding Islamic Finance The stakeholders must have the knowledge that all Islamic modes have potential for development. Shirkah-based (PLS) modes that provide the much-needed risk-related funds for development of trade, business and industry can be used for short-, medium- and long- term project financing, import financing, preshipment export financing, working capital financing and financing of most single transactions. The institution of Mudarabah serves as a basis of business to be conducted by combining funds and the expertise of different groups of people. Mudarabah Sukuk can be issued to mobilize funds and strengthen trading and industrial activities. SPVs can manage such assets and conduct business for their benefit and that of the Sukuk holders. This could generate higher rates of return for the investors relative to the return realizable on any interest-based investment, as discussed in Chapter 12. In the case of big projects, IFIs may form consortia to issue certificates to the public for subscription. Similarly, they can carry out work on infrastructure and socio-economic projects in coordination and partnership with engineering firms. The non-PLS techniques not only complement the PLS modes but also provide flexibility of choice to meet the needs of different sectors and economic agents in society. Murabaha, with less risk, has several advantages vis-à-vis other techniques and can be helpful in meeting the needs of risk-averse investors, employment generation and alleviation of poverty. Leasing is very much conducive to the formation of fixed assets and medium- and long-term investments. Salam has a large potential in financing productive activities in crucial sectors, particularly agriculture, agro-based industries and the rural economy as a whole. To realize this potential, IFIs could organize a forward commodity trade market on the basis of Salam. This would provide not only a nonspeculative forward market for resource mobilization and investment, but would also be a powerful vehicle for rural development. On the basis of the above, it can be said that supply of and demand for investment capital would continue in an interest-free scenario with the additional benefit of a larger supply of risk-related capital, more efficient allocation of resources and an active role of banks and financial institutions, as required in the asset-based Islamic discipline of finance. This could be helpful in achieving the objective of development with distributive justice by increasing the supply of risk capital in the economy, facilitating capital formation and growth of fixed assets and real sector business activities. But a point of concern in this regard is that Islamic banks are obliged to work with a number of limitations and constraints, most important among which is competition with the mainstream banks. They have to use the same benchmarks and apply charges comparable with the main conventional market. As such, it may take more effort and relatively a much longer time to achieve visible socio-economic results. As regards points 3 and 4 above, the moral dimension is the main ingredient of Islamic banking and finance. IFIs may implement a code of conduct reflecting Islamic values and principles, strictly ensuring that it is demonstrated in the management procedures, operations and overall behaviour of their incumbents (see the AAOIFI’s Code of Ethics). This is particularly relevant in Muslim majority areas, where Islamic culture has a deep bearing on the approaches and ideas of the masses. Islamic banking is one aspect of an Islamic way of life and if an Islamic banker is involved in any unethical or prohibited practices, it could undermine the integrity and credibility of the system. Therefore, ensuring good governance by IFIs on the basis of Islamic behavioural principles and moral and business ethics is a big challenge for the integrity and long-term health of IFIs. The ultimate objective in this regard should be to provide the best services at competitive rates and to strike a balance between the interests of the shareholders and those of the The Way Forward 469 depositors. It has been observed that to compete with conventional financial institutions, some IFIs have been giving fixed rates of return, either by paying from the shareholders’ part or by allocating more to the shareholders in the case of higher profits. Although profit equalization reserves can be maintained with sufficient disclosure and transparency, apportioning profits just to compete in the market and without taking the partners into confidence is against the spirit of the Shar ¯ ı´ah. An effective enforcement of the code of conduct would enhance the integrity of the system. Structure of Financial Institutions What the structure of Islamic banks should be is another issue. Should they become traders or business entities? In most countries, they have to operate analogously to the conventional banks, within the national banking systems in general and in respect of international financial and business transactions in particular. Although the philosophy, process and the procedures of Islamic banks differ, they do serve as financial intermediaries and as a link in the chain of the banking system. Like conventional banks, they mobilize savings and undertake the financing of economic and social development activities for the benefit of the economies where they operate. While fulfilling this objective, which is indisputably accepted by all Islamic scholars, they have to undertake real sector business instead of dealing in money on the basis of interest. This implies that Islamic banks’ procedures should be different from those of the conventional banks, in the sense that the latter deal in money while Islamic banks have to deal in goods. Islamic banks’ modus operandi is also different from that of the business community in general, because they do not normally hold inventories of the goods for selling or leasing. They rather purchase the goods/assets on requisition of their clients for letting or onward sale, and there is no Shar ¯ ı´ah objection in this regard. Accordingly, the Murabaha Standard issued by the AAOIFI has been captioned the Standard for Murabaha to Purchase Orderer. Concern has been shown by a number of writers that IFIs concentrate on short-term commercial financing, like the conventional banks. An active developmental role is expected of them that actually provides the rationale for their existence. The concern is genuine, but to combat it would require some structural changes and amendments in legal and regulatory frameworks, which are crucial for ensuring Shar ¯ ı´ah compliance and for better performance of the IFIs. Accordingly, banking business should not be taken as a sacred cow to preclude any change in its tools, processes or operations. Survival in the world of finance, which is undergoing rapid transformation, is possible only through adjustments and transformation, needed from time to time due to changing ground realities. In the global competitive environment, IFIs must diversify their operations to offer broader portfolio services, both to savers/investors and fund users. By providing only short-term commercial loans, they cannot compete with giant conventional banks. They should increasingly provide project and infrastructure financ- ing through Shirkah- and Ijarah-based modes. They may also provide corporate advisory services like issuance of Shar ¯ ı´ah-compliant Sukuk/certificates and balance sheet and corpo- rate restructuring, etc. through syndication arrangements. IFIs also have to undertake all sorts of business – from retail banking to fund management and corporate services – by effecting some structural changes. This would require close coordination between central banks and SECs in respective countries, enabling the IFIs to adopt suitable models and structures for business, keeping in mind the demands of the market and the Shar ¯ ı´ah principles. [...]... Gross national income Islamic Bank Islamic banking branches (stand-alone) Islamic Dinar Islamic Development Bank Islamic depository receipts Islamic export refinance scheme Islamic financial institutions Islamic Financial Services Board (Malaysia-based) Institute of Islamic Banking and Insurance (London) International Islamic Financial Market (Bahrain-based) International Institute of Islamic Economics... Institute of Islamic Thought Islamic inter-bank money market (Malaysia) International Islamic Rating Agency International Islamic University International Monetary Fund Islamic micro -finance institutions Initial public offering (shares) Islamic Research Institute (Islamabad, Pakistan) Internal rating system Islamic Research and Training Institute, research and training arm of IDB (Jeddah) Islamic Trade... efforts by the Islamic financial institutions, Shar¯´ah scholars, central banks/regulators, universities, ı business schools and the student community The universities should sense the huge need for providing competent human resources to the Islamic finance industry In this context, the focus has to be on the philosophy of Islamic finance as it has evolved today and the practical operations of Islamic financial... and regulators is ı crucial They may accommodate Islamic finance for reasons both of principles and practical importance Realization of the potential of Islamic finance will require structural adjustments enabling Islamic financial institutions to deal with real sector business, implementation of trading, leasing and real-estate related contracts using Islamic modes of financing Fixity of rates is no... for Islamic banking to ensure Islamic banks’ functioning in line with the Shar¯´ah principles ı • A Shar¯´ah board or at least a Shar¯´ah advisor has to be appointed by each Islamic ı ı banking institution (IBI) as per fit and proper criteria approved by SBP’s Shar¯´ah ı board • Each IBI has to conduct internal Shar¯´ah audit at least once in a year ı 10 Chapra and Khan, 2000 474 Understanding Islamic. .. with Islamic ethical values, can be instrumental in marketing the products in Muslim and other communities and enhancing the acceptability of the new discipline This challenge can be met by imparting quality training to all those who are related in one way or another to Islamic financial institutions about the philosophy, products and practices of Islamic finance The long-term growth of Islamic finance. .. freight Council of Islamic Ideology (Pakistan) Collateralized loan obligations Cash management accounts Central bank Musharakah certificates (Sudan) Certificates of deposit Certificates of investment Carried over transactions Development finance institutions Diminishing Musharakah Delivery order Daily product basis (deposit management) External debt liability 482 Understanding Islamic Finance EDR EFS... most dominant and common model of Islamic banking in practice today comprises a dual system, whereby interest-based and Islamic financial institutions are working side by side While the growth of the Islamic financial system is a challenge to the conventional interest-based banks, the adoption of Islamic financial modes by the conventional banks is a challenge to the Islamic banks This situation, on... economists and social scientists is necessary.”11 11 Siddiqi, 2006, p 17; also see Parker, 1999 476 Understanding Islamic Finance For achieving the objective of Shar¯´ah compliance, the active involvement of people ı having deep understanding of Shar¯´ah matters, socio-economic issues and principles of ı finance is crucial Credibility has to be established, both at national and international levels For... apostlehood of Prophet Muhammad (pbuh), Akhirah and conformity to the Shar¯´ah in behaviour ı 488 Understanding Islamic Finance F¯ sid: A voidable or defective contract (according to division of contracts with respect to legality as a per Hanafi Fiqh) due to nonfulfilment of any condition required for valid contracts Fatwah: A religious decree or edict; plural Fat¯ wa a Fiqh: Islamic jurisprudence; . facing Islamic banking, due to which it might not be able to achieve the results proclaimed in Islamic finance theory, at least in the short or medium terms. 468 Understanding Islamic Finance The. Jones Islamic Index, Al-Meezan Islamic Investment Index and the Malaysian Islamic 6 For the evolution of Islamic banking and analysis of the movement, see Siddiqi, 2006a, pp. 1–48. 462 Understanding. related in one way or another to Islamic financial institutions about the philosophy, products and practices of Islamic finance. The long-term growth of Islamic finance will require developing